‘Credit crunch’ would hit bank dividends: UBS

Australia's banks will find it difficult to maintain their dividends if there is a disorderly correction in the housing market, says UBS.

In a research note on the Australian banking sector, UBS analyst Jonathan Mott laid out a 'credit crunch' scenario under which the banks would be forced to cut dividends.

Tightening credit conditions and negative sentiment are already causing the Australian housing market to slow following a prolonged boom in Sydney and Melbourne, said Mr Mott.

Other factors that have UBS concerned are the royal commission's "rigorous interpretation" of the responsible lending laws, APRA's focus on sound lending practices, and the Labor Party's pledge to limit negative gearing should it win the next federal election.

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>In a research note on the Australian banking sector, UBS analyst Jonathan Mott laid out a 'credit crunch' scenario under which the banks would be forced to cut dividends.

Tightening credit conditions and negative sentiment are already causing the Australian housing market to slow following a prolonged boom in Sydney and Melbourne, said Mr Mott.

Other factors that have UBS concerned are the royal commission's "rigorous interpretation" of the responsible lending laws, APRA's focus on sound lending practices, and the Labor Party's pledge to limit negative gearing should it win the next federal election.

"Given these headwinds we expect a sharp slowdown in credit growth. Whether this turns into a more disorderly correction, or if there are any potential political interventions remains to be seen," said Mr Mott.

The question will be, he said, whether banks can maintain their dividends.

If there is an orderly slowdown in the housing market, the banks should be able to generate enough capital to maintain dividends, Mr Mott said.

But dividends may need to be cut if banks' net interest margins come under pressure from high funding costs or competition, he said.

If the banks' impairment charges rise faster than anticipated, there would be an increased likelihood of cuts to dividends, Mr Mott said.

"Further, the announced divestments of wealth management businesses could potentially reduce the earnings power of the [major banks], especially if demerged," he said.

The UBS 'base case' remains housing credit slowing towards zero by 2020-21 and house prices falling by 5 per cent or more in the next year, which would see bank dividends remain at their current level.

In UBS's downside scenario – which Mr Mott says could result in a 40 per cent drop in bank share prices – credit growth would fall by 2-3 per cent and impairment changes would rise "significantly", putting pressure on bank net interest margins.

"Dividends would need to be cut in this scenario. Given the leverage in the banking system, accurately predicting the extent of a downturn is very difficult, as was seen in 2008," Mr Mott said.